Management Advisory Services MAS03

COST VOLUME PROFIT ANALYSIS

Cost volume profit analysis is a tool used for decision making that utilizes the relationship among
• Volume of sales • Variable costs • Profit
• Sale price • Fixed costs • Mix of sales
CVP analysis uses the contribution margin approach

Contribution margin approach

Contribution margin income statement:

Sales P xxx
Variable costs (xxx)
Contribution margin P xxx
Fixed costs (xxx)
Operating income P xxx .

The contribution margin income statement

▪ Is used only for internal decision making (not PFRS compliant)
▪ Segregates costs according to their behavior (variable vs fixed) instead of
whether they are product costs or period costs (CGS vs SGA expenses)
▪ Is helpful in aiding sensitivity (“what if”) analyses.

Problem 1 (Demo). Given the following projected CM income statement for the coming year:

Sales (100 units) P 10 000

Variable costs 3 000
Contribution margin P 7 000
Fixed costs 4 000
Operating income P 3 000

1. Determine the total contribution margin, unit contribution margin, contribution margin
ratio.
2. How much will operating income be if only 80 units will be sold instead of 100?
3. How much will operating income increase if 150 units will be sold instead of 100?
4. How much will operating income be if variable cost per unit is P32?

Problem 2 (Bobadilla). Tamarine Company earned P50 000 on sales of P400 000. It earned P70
000 on sales of P450 000. The amount of total fixed costs for Tamarine Company is:

Assumptions underlying CVP Analysis

In order for CVP to work, the following

assumptions should be made:
1. Revenues and costs behave in a linear manner
2. Costs can are either variable or fixed, if mixed, it can be segregated to its variable
and fixed components.
3. Only volume affects the costs and revenues
4. Production volume = sales volume
5. Product mix is constant

Problem 3. Given the following figures, construct a CVP Graph

Unit sales price P 10

Unit variable cost 7
Total fixed costs 3 000
Breakeven point is the level of sales where total revenues equals total costs. At this point, there
is no profit or loss. CVP analysis can also aid management in determining the level of sales to
reach a desired profit (target profit point)

1. What is the breakeven point in units (BEPU)? The breakeven point in revenues (BEPR)?
2. If the company desires a profit of P6 000, what is the target profit sales in units (TPPU)?
What is the target profit sales in revenues (TPPR)

Approaches in CVP analysis

1. Unit contribution margin method
2. Contribution margin ratio method.

Unit contribution margin Contribution margin ratio

BEPU BEPS

TPPU TPPS

Problem 4 (Breakeven and target profit analysis). Consider the following:

Fixed expenses P 78 000

SP 20
UVC 8
Target net profit 42 000

1. How many unit sales are required to breakeven?

2. How many unit sales are required to earn the target net profit?
3. How much revenues are needed to breakeven?
4. How much revenues are needed to earn the target net profit?

Assume a tax rate of 20%

5. How many unit sales are required to earn the target net profit?
6. How much revenues are needed to earn the target net profit?
Problem 5 (Breakeven Analysis, Bobadilla). The Red Lions Brotherhood is planning its annual
Riverboat Extravaganza. The Extravaganza committee has assembled the following expected
costs for the event:
Dinner per person P 70
Programs and souvenir per person 30
Orchestra 15 000
Tickets and advertising 7 000
Riverboat rental 48 000
Floor show and strolling entertainment 10 000

The committee members would like to charge P300 per person for the evening’s activities
1. Assume that only 250 persons are expected to attend the extravaganza, what ticket price
must be charged to breakeven?
2. Assume that the ticket price is P300, how many persons should attend to breakeven?

Margin of Safety (MoS)

MOS is the difference between actual or budgeted sales and the breakeven point. This pertains
to the amount that the budgeted or actual sales can fall before it will result to a loss. (A buffer
zone).
MoS = Actual or budgeted sales - Breakeven sales

The margin of safety can also be expressed in a ratio. This is known as the margin of safety
ratio.
MosR = Actual or budgeted sales - Breakeven sales
Actual or budgeted sales

These calculations are helpful in risk management.

Problem 6. Given the following income statement, answer the following questions.
Sales revenue P 400 000
Variable costs 260 000
Contribution margin P 140 000
Fixed costs 105 000
Operating income P 35 000

1. What is the CMR?

2. What is the BEPSR?
3. What is the MoS?
4. What is the MoSR?
5. Interpret your answers.
6. What is the sales (profit) margin?

Problem 7 (MOS, Bobadilla) The following information pertains to Hennin Corporation for the
year ending December 31, 2009:
Budgeted sales P 1 000 000
Breakeven sales 700 000
Budgeted contribution margin 600 000
Cashflow breakeven 200 000

1. What is the margin of safety?

Problem 8 (MOS, Bobadilla) Marsman Company had a margin of safety ratio of 20%, variable
costs of 60% of sales, fixed costs of P240 000, a breakeven point of P600 000, and an operating
income of P60 000 for the current year. What are the current year’s sales?
Problem 9 (MOS, Bobadilla) Based on the following:
Profit margin before tax based on sales 8%
Margin of safety ratio 20%
Fixed costs P1 200 000
Variable cost of goods sold 25%

1. What is the amount of sales?

2. What is the variable selling and administrative expense?

Cost structure is how a company uses a mix of variable costs and fixed costs.
Cost structures can either be:
1. High variable costs – low fixed costs
2. Low variable costs – high fixed costs

The Indifference point is the level of sales wherein

YCost structure A = Y Cost structure B

Problem 10 (Indifference point, Bobadilla) The following data relate to Guitar Company which
sells a single product.

Unit selling price P 50.00

Purchase cost per unit 20.00
Sales commission (15% of sales) 7.50
Monthly fixed costs P 450 000.00

The firm’s salesmen would like to change their compensation

from a 15% commission to 5% plus P100 000 per month fixed salary.
Presently, the salesmen receive commission only.

1. At what sales volume in units will the two compensation plans be indifferent?

Problem 11 (Indifference point, Bobadilla). Anilao Ski Corporation recently expanded its
manufacturing capacity to allow it to produce up to 15 000 pairs of cross-country skis of either
the mountaineering model or the touring model. The sales department assures management that
it can sell between 9 000 and 13 000 pairs (units) of either product this year. Because the
models are very similar, Anilao Ski would produce only one of the two models. The following
data were compiled by the accounting department.

Mountaineering Touring
Selling price per unit P 88.00 P 80.00
Variable cost per unit 52.80 52.80

Fixed cost will total P369 600 if the mountaineering model is produced but will be only P316 800
if the touring model is produced. (Income tax rate = 40%)

1. The total sales revenue at which Anilao Ski Company would make the same profit or loss
regardless of the ski model it decided to produce is?
Degree of operating leverage

What is leverage? ____________________________________________________

Leverage can either be Operating leverage

Financial leverage

Problem 12. A company is currently considering changing its cost structure. From a Refer to the
following pro-forma income statements at the budgeted sales.
Cost structure A – Manual Cost structure B – Automated
Sales revenue (100 u) P 100 000 P 100 000
Variable costs (70 000) (10 000)
Contribution margin P 30 000 P 90 000
Fixed costs (10 000) (70 000)
Operating income P 20 000 P 20 000

1. Recreate both income statements if sales increased by 10%.

2. Recreate both income statements if sales decreased by 20%.

3. What is the degree of operating leverage of the budgeted sales for cost structure A?
4. What is the degree of operating leverage of the budgeted sales for cost structure B?

Problem 13 (DOL, Bobadilla). Below is the income statement for Blender Co. for 2010?
Sales P 400 000
Variable costs (125 000)
Contribution margin P 275 000
Fixed costs (200 000)
Profit before tax P 75 000 ,

1. What is the degree of operating leverage for Blender Company for 2010?

Problem 14 (DOL, Bobadilla). The Oregano Watch Company manufactures a line of ladies’
watches which are sold through discount houses. Each watch is sold for P1 500; the fixed costs
are P3 600 000 for 30 000 watches or less, variable cost is P900 per watch.
1. What is Oregano’s degree of operating leverage at sales of 12 000 watches?
2. What is the increase in profit if sales increased by 2 000 watches?

Multi-product CVP
Note: in multiproduct CVP, always assume a constant mix of product.
Sales mix can be stated in terms of 1. Sales Unit Product mix (SUPM)
2. Sales Revenue Mix (SRM)

Rule: GIVEN SUPM -> USE WAUCM to arrive at BEP(U)

GIVEN SRM -> USE WACMR to arrive at BEP(SR)
Problem 15 (Multi-product CVP). Given:

The sales unit product mix between products A and B are 1:2. Sales price and variable
costs of the two are as follows:
A B
SP P8 P6
VC 2 3 ,

Fixed costs is P600 000.

a. Determine the sales revenue mix.

b. What is the WAUCM?
c. What is the WACMR?

d. What is the breakeven point (units)?

How many sales units for A?
How many sales units for B?
e. What is the breakeven point (sales revenue)?
How much of these are from A?
How much of these are from B?

f. What is the target profit sales in units if target profit is P300 000? Use 2 approaches.
g. What is the target profit sales in sales revenue if target profit is P900 000? Use 2
approaches

Problem 16 (Multi-product CVP, CMA). Caftur Company has fixed costs of P300 000. It produces
two products, X and Y. Product X has a variable cost percentage equal to 60% of its P10 selling
price. Product Y has a variable cost percentage equal to 70% of its P30 selling price. For the
past several years, sales of Product X averaged 66.666% of the sales of Product Y. That ratio is
not expected to change.
a. What is Caftur’s breakeven point in pesos?
b. How many units of Product Y will Caftur sell at the breakeven point?
c. Assume that Caftur Company achieved its planned breakeven level of sales in pesos, but
the mix of products sold was one-to-one. All actual costs and units selling prices
equaled budgeted amounts. What is the impact on profitability?